Crypto industry could lead tax fight to Supreme Court

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The cryptocurrency community has launched an all-out but unsuccessful lobbying blitz to water down proposed new tax reporting rules that could be enacted as early as next week. Now the industry is changing tack and bracing for a constitutional battle in court that could help redefine Fourth Amendment protections against unreasonable government inquiries into Americans’ financial lives.

Proposed as part of a bipartisan infrastructure bill, the rules would require anyone who regularly provides a service that executes digital asset transfers to report those transactions to the Internal Revenue Service as stock brokers must. do this for stock and bond transactions today. If interpreted to the fullest by the IRS, the rules could also require the reporting of all digital asset transactions over $ 10,000, whether or not they are made through a broker.

This law will kill technology, Abraham Sutherland, a former White House and State Department attorney and adviser to the Proof of Stake Alliance, which advocates for regulatory clarity in the crypto industry, told MarketWatch.

Sutherland is particularly concerned about the $ 10,000 transaction reporting requirement, which could require any American who receives a digital asset to report the social security number, address, and profession of the payer to the IRS, or else mandatory fines, a potential felony conviction and a five-year prison sentence.

Why would someone risk a crime by transacting with digital assets when you can just go back to banks that will report your financial transactions to the government for you? Sutherland said.

Supporters of the proposal say the reporting requirements are necessary for the IRS to collect taxes that are already owed to the government, and a new law would simply put cryptocurrencies on a par with cash.

In April, IRS Commissioner Charles Rettig told the Senate Finance Committee that the lack of reporting requirements for crypto transactions contributed to more than $ 1 trillion a year in taxes. bad debts owed to the federal government, and asked Congress to pass legislation to address the problem.

I think we need the authority of Congress, he said. We are frequently challenged, and it is essential to have a clear decree from Congress on the authority for us to collect this information, Rettig said, adding that most crypto virtual currencies are designed to stay out of the way. radar screen.

A challenge of the Fourth Amendment

As a rule of thumb, we don’t oppose the equal treatment of cash and cryptocurrencies, but the reporting provision is a draconian watchdog rule that should have been declared unconstitutional long ago, wrote Peter Van Valkenburgh. , research director at crypto think tank Coin Center, in a recent blog post. Extending it to cryptocurrency transactions would further erode the privacy of law-abiding Americans.

Van Valkenburgh said in an interview with MarketWatch that Coin Center, whose board includes some of the biggest players in the industry, would likely sue the government if these new reporting requirements go into effect, as the legislation proposes in 2024.

One legal theory the organization would advance is that the law violates U.S. Fourth Amendment rights against unreasonable government searches and seizures.

There is a long history of Fourth Amendment challenges to laws requiring U.S. financial reporting to government. In part because of challenges to the Bank Secrecy Act of 1970, a law that requires financial institutions to help the U.S. government detect and prevent money laundering, federal courts have developed the so-called third party doctrine which states that citizens do not have the right to privacy with regard to information they voluntarily give to a third party.

The BSA requires financial institutions to report all cash transactions over $ 10,000 to government authorities, but in 1984 Congress extended this requirement to all businesses in an effort to increase tax compliance and increase tax returns. revenues, just as Congress aims to do with crypto reports.

Following the passage of the 1984 law, any entrepreneur who sold a good or service for more than $ 10,000 in cash was required to report detailed personal information about their customers to the government.

Forcing people to report their trade counterparts in this way is not a neutral third party, it is really a person, spying on or informing another person, Van Valkenburgh said. It is difficult to imagine how the doctrine of the third party was supposed to apply to a transaction with only two parties.

John Wesley Hall, criminal defense attorney and Fourth Amendment litigation expert, told MarketWatch that the legal profession was the first to oppose the arrangement. In the 1980s, several lawsuits were filed in federal courts against the requirement that lawyers monitor their clients on behalf of the government, he said.

I argued that same issue in the 1980s and 1990s and we lost miserably back then, every time, he said. There is no reasonable expectation of privacy because Person A can always report Person B.

Carpenter to the rescue?

Van Valkenburgh argued that the Supreme Court has a very different attitude to third party doctrine today than it did when these cases were pending over 30 years ago, as evidenced by the landmark 2018 case of Carpenter v. United States.

In Carpenter, the Supreme Court determined that the common police practice of subpoenaing cellphone recordings to determine the location of potential suspects was a Fourth Amendment violation, even though someone willingly and implicitly accepts that the companies users access this information when they register for a mobile phone. service.

The Supreme Court said that this information is not really provided voluntarily by customers, as cellphones are a necessity in everyday life, Van Valkenburgh said. You can’t really be a functioning part of the economy without having one, so it’s not really voluntary.

In addition, the court said that information that the government seeks from a service provider must be present for a legitimate business purpose and that a mobile phone company does not really have a legitimate reason to keep a full record. and full of a client’s location.

With Carpenter in mind, what is the legitimate aim of any random businessman collecting the social security number of any customer who wishes to transact in cash or cryptocurrency? Van Valkenburgh wondered.

Blockchain and privacy

Even if the cryptocurrency industry and privacy advocates succeed in convincing federal courts that the reporting requirements of the bipartisan Infrastructure Bill and other similar laws are unconstitutional, this will be the start. and not the end of a necessary discussion about privacy and blockchain technology, says Paul. Belonick, Professor of Law and Director of the UC Hastings Innovation Center.

After all, cryptocurrencies operate through public transaction ledgers. Anyone with sufficient technical knowledge can glean a lot of information from studying these records, and the government has been easy to use this information to track down criminals and recover ill-gotten gains.

This can lead to an ironic outcome in which cryptocurrencies succeed in transforming the global financial system and weakening incumbent financial institutions that have become major partners in government enforcement, but do so in a way. which potentially makes monitoring easier.

We know the government has worked, sometimes with private companies, to de-anonymize people on the blockchain, Belonick told MarketWatch. The government, without any political intervention, could possibly de-anonymize most people eventually.

Belonick said if crypto and privacy advocates are to avoid this outcome, they should consider proactively pushing Congress to create laws that prevent this type of activity without first securing a search warrant for them. courts.

Hall, the criminal defense attorney, doubts Congress will do anything to tie the hands of federal law enforcement. He pointed to recent objections by Republican lawmakers to the possibility that the Jan. 6 Commission subpoena their phone records. If they don’t like third party doctrine, Congress can just pass a law saying these records cannot be collected without a warrant.

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